FBIAS™ for the week ending 7/24/2015

In the “decades” timeframe, the question of whether we are in a continuing Secular Bear Market that began in 2000 or in a new Secular Bull Market has been the subject of hot debate among economists and market watchers since 2013, when the Dow and S&P 500 exceeded their 2000 and 2007 highs. The Bear proponents point out that the long-term PE ratio (called “CAPE”, for Cyclically-Adjusted Price to Earnings ratio), which has done a historically great job of marking tops and bottoms of Secular Bulls and Secular Bears, did not get down to the single-digit range that has marked the end of Bear Markets for a hundred years, but the Bull proponents say that significantly higher new highs are de-facto evidence of a Secular Bull, regardless of the CAPE. Further confusing the question, the CAPE now has risen to levels that have marked the end of Bull Markets except for times of full-blown market manias. See graph below for the 100-year view of Secular Bulls and Bears.

Even if we are in a new Secular Bull Market, market history says future returns are likely to be modest at best. The CAPE is at 26.7, down from the prior week’s 27.3, and approximately at the level reached at the pre-crash high in October, 2007. In fact, since 1881, the average annual returns for all ten year periods that began with a CAPE at this level have been just 3%/yr (see graph below).

This further means that above-average returns will be much more likely to come from the active management of portfolios than from passive buy-and-hold. Although a mania could come along and cause the CAPE to shoot upward from current levels (such as happened in the late 1920’s and the late 1990’s), in the absence of such a mania, buy-and-hold investors will likely have a long wait until the arrival of returns more typical of a rip-snorting Secular Bull Market.

In the big picture:

The “big picture” is the months-to-years timeframe – the timeframe in which Cyclical Bulls and Bears operate. The US Bull-Bear Indicator (see graph below) is at 50.81, down from the prior week’s 52.3, and continues in Cyclical Bull territory. The current Cyclical Bull has taken the US and some of Europe to new all-time highs, but many of the world’s markets have yet to top 2007’s levels – particularly in the Emerging Markets area.

In the intermediate picture:

The intermediate (weeks to months) indicator (see graph below) is Negative and ended the week at 11, down sharply from the prior week’s 17. Separately, the quarter-by-quarter indicator – based on domestic and international stock trend status at the start of each quarter – gave a positive indication on the first day of July for the prospects for the third quarter of 2015.

Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2 above), whether we are in a new Secular Bull or still in the Secular Bear, the long-term valuation of the market is simply too high to sustain rip-roaring multi-year returns. In the Cyclical (months to years) timeframe (Fig. 3 above), all major equity markets are in Cyclical Bull territory. In the Intermediate (weeks to months) timeframe (Fig. 4 above), US equity markets are rated as Negative. The quarter-by-quarter indicator gave a positive signal for the 3rd quarter: US equities were in an uptrend at the start of Q3 2015, sufficient to signal a higher likelihood of an up quarter than a down quarter.

In the markets:

Stocks declined for the week as disappointing earnings from some key companies weighed on the benchmarks. The continued slump in commodity prices also added to the gloom. The Dow Jones Industrial Average fell back into negative territory for the year-to-date, giving up 517 points and -2.86% for the week. The tech-heavy Nasdaq also declined, but less than the blue chips, at -2.33%. The LargeCap S&P 500 sank -2.21%, the MidCap S&P 400 ended down -2.06%, and the SmallCap Russell 2000 fell the hardest, down -3.24%. Canada’s TSX, hard hit by the continuing declines in gold and oil, retreated by -3.12%.

In international markets, Developed International declined a relatively modest-2.17%, but Emerging Markets plunged -4.39%. Weakness spread across European markets as the United Kingdom’s FTSE dropped -2.88%, Germany’s DAX gave up -2.79%, and France’s CAC40 declined -1.31%. In Asia, China’s Shanghai index bucked the trend and had its second week of gains after its plunge last month. Japan’s Nikkei held the 20,000 level, finishing the week down 0.52%.

In commodities, an ounce of gold continued its 6th week of declines, down -2.99%. Silver also continued its decline, down -0.68%. A barrel of West Texas Intermediate crude oil plunged -5.55% to $47.96 a barrel, its 6th straight weekly decline. Copper continued its relentless plunge, down an additional -4.25%. Copper has dropped over 17% in 10 weeks. If the price of copper truly is a harbinger of coming worldwide economic conditions, as many believe it to be, there must be big economic trouble brewing.

In US economic news, initial jobless claims reached a 42 year low as there were 255,000 initial jobless claims last week, the lowest since November 1973. Existing home sales jumped +9.6% versus a year ago and ran at a 5.49 million annual pace in June, beating expectations of 5.4 million. Existing home prices reached an eight year high and sales were at the fastest pace since February, 2007. All regions saw year-over-year gains, for the sixth straight month. The Federal Housing Finance Agency (FHFA)’s home price index rose +5.7% versus a year ago, and has returned to its 2006 levels. But despite the strong showing in existing home sales, new-home sales widely missed expectations as sales ran at a rate of 482,000 versus expectations of 550,000 in June, and down 7% from May.

The Conference Board’s Leading Economic Indicators (LEI) index was stronger than expected in its June reading. The index rose +0.6%, reaching a level not seen since 2006.

Credit reporting firm Experian reported that consumer defaults were near all-time lows in June as Americans remained cautious about expanding their borrowing, even as the economy improves. In the report Experian also noted that a pickup in inflation may pressure consumers but that “consumers remained optimistic and are primed to spend.”

St. Louis Federal Reserve President James Bullard stated that the likelihood of a September fed rate hike is greater than 50%. He said that the Fed expects the economy above 3% in the second half and that there was no longer a need for “emergency” monetary policy, in his opinion, and that turbulence in Greece and China should not influence US policymaking.

In Canada, wholesale shipments declined -1% in May, missing forecasts of just a -0.2% drop; however, April was up a stronger +1.7%. A weekly gauge of Canadian consumer sentiment dropped to a four month low last week after the Bank of Canada said the nation’s economy “contracted modestly”. The latest telephone polling of Canadian consumers by Nanos Research Group shows optimism over the economy’s prospects has deteriorated to the lowest level since 2008. Canadians also grew more pessimistic about the outlook for real estate, job security, and personal finances. Canada’s Central Bank reduced its 2015 gross domestic product forecast by almost half to just 1.1% and cut its key interest rate to 0.5%. The bank blames the weakness on damage from the oil price shock and the “puzzling” lack of a rebound in non-energy exports.

In the United Kingdom, minutes released by the Bank of England revealed that the bank has moved closer to a rate hike as policymakers were inclined to vote to raise rates in early July, but market turbulence in China and Greece deterred them from taking action. The central bank’s governor has hinted that a rate rise is due sometime in 2015. Markit’s flash Purchasing Managers Index (PMI) for Eurozone composite activity declined -0.5 point to 53.7, and the manufacturing component dropped -0.3 point to 52.2. Markit noted that these numbers are still relatively strong, given that the region has struggled to come back from the downturn.

Strong exports in the second quarter strengthened the German economy, according to the Bundesbank. Orders for domestic and international goods also bolstered industry, the central bank said. Producer prices came in matching expectations of a -0.1% dip in June. For the year, the German producer price index is -1.4% lower.

In China, manufacturing activity declined in July missing expectations for a slight gain, according to the flash PMI. It reached a 15 month low of 48.2, down from 49.4, and remained in contraction (<50) territory. New orders, new export orders, and employment all decreased.

Finally, the price of an ounce of gold has continued to slide, as noted above, which has frustrated gold investors who believe that the various central banks around the world, engaging in profligate amounts of quantitative easing, will inevitably debase their nation’s currency and lead to inflation—or even hyperinflation. Some economists and financial analysts view gold as a “barbarous relic”—the term for gold believed to be first coined by John Maynard Keynes. Warren Buffett said this about gold in a speech he gave at Harvard in 1998: “(It) gets dug out of the ground in Africa or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” In truth, there are lots of uses for gold other than simply putting it in a vault – some of them obvious, some not.

Here is a table from Morgan Stanley that details the source and destination of gold. Not surprisingly, Jewelry is the #1 destination, with Coins the #2 destination. Surprisingly, though, dentistry still consumes 55 metric tons of gold annually, and electronics another 300 metric tons. “Investment” is just 25% of total demand.

The ranking relationship (shown in Fig. 5) between the defensive SHUT sectors (“S”=Staples [a.k.a. consumer non-cyclical], “H”=Healthcare, “U”=Utilities and “T”=Telecom) and the offensive DIME sectors (“D”=Discretionary [a.k.a. Consumer Cyclical], “I”=Industrial, “M”=Materials, “E”=Energy), is one way to gauge institutional investor sentiment in the market.

The average ranking of Defensive SHUT sectors rose to 12.3 from the prior week’s 13, while the average ranking of Offensive DIME sectors fell to 18.5 from the prior week’s 18.3. The Defensive SHUT sectors expanded their lead in rankings over the Offensive DIME sectors. Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.

Summary:

The US has led the worldwide recovery, and continues to be among the strongest of global markets. However, the over-arching Secular Bear Market may remain in place globally even as new highs are reached in the US.

Because the world may still be in a Secular Bear, we have no expectations of runs of multiple double-digit consecutive years, and we expect poor market conditions to be a frequent occurrence. Nonetheless, we remain completely open to any eventuality that the market brings, and our strategies, tactics and tools will help us to successfully navigate whatever happens.

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The opinions expressed on this site are those solely of David M. Anthony and do not necessarily represent those of Anthony Capital, LLC (AC) or Fact Based Folios.com (FBF). This website is made available for educational and entertainment purposes only. Dave Anthony is an Investment Adviser Representative of AC and director of FBF, an investment advisers registered with the state of Colorado. This website is for informational purposes only and does not constitute a complete description of the investment services or performance of AC. Nothing on this website should be interpreted to state or imply that past results are an indication of future performance. A copy of AC's Part II of Form ADV and privacy policy is available upon request. This website is in no way a solicitation or an offer to sell securities or investment advisory services. Dave Anthony, AC, and FBF disclaim responsibility for updating information. In addition, Dave Anthony, AC, and FBG disclaim responsibility for third-party content, including information accessed through hyperlinks. -